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Thoratec Corporation (NASDAQ:THOR)

Q3 2011 Earnings Call

November 1, 2011 04:30 pm ET

Executives

Taylor Harris - Senior Director, IR and Business Development

Gary Burbach - President & CFO

Roxanne Oulman - Interim CFO

Analysts

Larry Biegelsen - Wells Fargo

Jason Mills - Canaccord

Bob Hopkins - Bank of America

Chris Pasquale - JPMorgan

Thomas Gunderson - Piper Jaffray

Rajeev Jashnani - UBS

Matt Taylor - Barclays Capital

Jayson Bedford - Raymond James

Bruce Nudell - Credit Suisse

Suraj Kalia - Rodman & Renshaw

Duane Nash - Wedbush Securities

Chris Sassouni - Eagle Asset Management

Operator

Good day and welcome to the Thoratec Corporation's third quarter earnings 2011 conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Taylor Harris. Please go ahead sir.

Taylor Harris

Thank you. Good afternoon and thank you for joining us today. With me are Gary Burbach, President and Chief Executive Officer; and Roxanne Oulman, the company's Interim Chief Financial Officer. Gary will discuss the key events of the company since our last call and Roxanne will review the financial results for the quarter and provide an update on guidance for 2011. We will then open the call to your questions.

Before turning the call over to Gary, I want to remind you that during the course of today's conference call and the question-and-answer session that follows, we may make projections or other forward-looking statements that are subject to the Safe Harbor provisions of the Securities laws regarding future events or the financial performance of the company.

We caution you that these statements are only predictions and that actual results may differ materially. We also alert you to the risks contained in the documents we file with the Securities and Exchange Commission, such as our annual and quarterly reports on Forms 10-K and 10-Q. We do not undertake any obligation to update or correct any forward-looking statements. Gary?

Gary Burbach

Thank you, Taylor, and good afternoon, everyone. Thoratec’s third quarter was highlighted by continued double-digit growth year-over-year in both pump units and revenues, strong new center activity, gross margin performance above our expectations and continued execution on our product and market development strategies. We experienced a sequential decline from our strong second quarter revenue performance and based on a few factors that we will described later, we are reducing our full-year revenue outlook by 1% to 2%. That said, we believe that the VAD market remains healthy and on track for sustained longer-term growth.

Additionally, based on our strong profitability results year-to-date, we are raising our 2011 guidance for gross margin and earnings per share. With respect to our financial results for the quarter, Thoratec generated revenues of $102.6 million, a 13% increase over revenues of $91.0 million in the third quarter of 2010. This increase was driven by a strong growth in pump revenues of 15%, with non-pump revenues continuing to expand at a slower pace due largely to the comparison against last year’s HeartMate external peripherals upgrade cycle.

Revenues moderated on a sequential basis reflecting the seasonality we typically see in the third quarter as well as the particularly strong performance in the second quarter of this year. In terms of geographic breakdown for the third quarter, we recorded revenues of $83.9 million in the United States versus $76.4 million in the prior year, an increase 10%. While international revenues were $18.7 million versus $14.6 million a year ago, representing an increase of 28% or 8% excluding both the positive $1.5 million impact of FX versus the third quarter of 2010 as well as the incremental international revenues associated with the Levitronix Medical acquisition.

Revenues from the HeartMate product line in the quarter were $87.6 million versus $80.6 million a year ago for an increase of 9%. Revenues from our acute surgical support line which includes CentriMag and PediMag were $7.2 million compared with $3.7 million a year ago. This strong performance include a growth in the core US CentriMag business of close to 50% as well as $1.6 million of incremental revenues recorded as a result of the Levitronix Medical transaction completed during the quarter.

Revenues from the Thoratec product line, the PVAD and IVAD were $7.2 million versus $6.2 million a year ago or an increase of 16%.

We experienced solid year-over-year unit growth in the quarter selling 853 pumps, an increase of 11% versus 766 pumps in the third quarter a year ago. In terms of pump shipments by geography, we shipped 665 pumps in the United States, an increase of 10% over 605 pumps a year ago and 188 internationally, an increase of 17% versus 161 a year ago.

Within the US, HeartMate II drove year-over-year unit growth with the large majority of growth continuing to come from the centers that adopted HeartMate II following the clinical trial.

On a sequential basis, all groups of centers in the US experienced a similar seasonal patterns with respect to HeartMate II volume.

As for Destination Therapy, just over 40% of our US HeartMate II implants during the third quarter were for the DT indication in line with the second quarter. In International markets, the PVAD franchise was the primary catalyst of year-over-year unit growth with the HeartMate II up modestly.

With respect to new center development, we added six HeartMate II centers in the US and two internationally during the quarter, bringing the total number of HeartMate II centers in the US to 141 and 139 internationally. This compares to 130 and 124 respectively at the end of 2010, and we believe we are on track to meet or exceed our previously stated 2011 target for new centre additions.

There are currently 99 centers in United States that have received vaccination therapy certifications from the joint commission. Eleven centers have submitted their applications to the joint commission and five have surveys scheduled before year end. I would now like to provide an update on our market development and educational programs.

Activities of medical conferences, clinical data publications and the roadmap study all of which is supporting the growing adoption of the HeartMate II. With respect to our market development programs we have spoken in previous calls about our wide range of initiatives designed to broaden awareness within the referring cardiology channel. The increased capacity in implanting centers and continue to improve clinical outcomes.

In terms of recent highlights we hosted our latest community cardiologist outreach event in Orlando during the second week of October. This event brought together potential referring cardiologist with the faculty of key opinion leaders and mechanical circulatory support. The program focused on topics such as patient selection, and post discharge patient management and the VAD reimbursement; it was attended by 140 clinicians, a significant increase compared to previous events.

We also continue to focus on increasing implants at our capacity with one important initiative being our fellows program which has attracted over 100 clinicians over the past few years, and is designed to facilitate expansion of the pool of both surgeons and cardiologists engaged in mechanical circulatory support therapy.

Later this month we will be hosting approximately 40 MCS fellows as part of our second event this year led by a faculty of squad leaders and designed to foster education on advanced heart failure therapy and the benefits of mechanical circulatory support.

We had a strong presence at recent industry conferences including the annual meetings of the Heart Failure Society of America and the European Association for Cardiothoracic Surgery.

At HFSA, there were significant number of VAD related panels, presentations and posters and we also hold the well-attended hands-on MCS workshop, the first upgrade HFSA. Another important development at HFSA was the discussion of the society’s guidelines for VAD therapy as part of a presentation by Dr. Joseph Rogers of Duke.

Dr. Rogers detailed the favorable improving patient outcomes with VAD and presented the case for increasing the level of evidence and strength of recommendation for VAD therapy within the heart failure treatment guidelines.

The Society’s former guidelines are not due for update for several more years, but we anticipate the release of an interim wide paper to address the issue.

Recent publications have continued to demonstrate HeartMate II's excellent clinical performance despite the challenging patient populations and wide range of centers in which it has been studied. Among the most important of these, was the study comparing outcomes of 1,496 commercial bridge-to-transplantation HeartMate II patients, with those of 486 patients who participated in the HeartMate II bridge-to-transplantation clinical trial.

The lead doctor was Dr. Ranjit John from the University of Minnesota and it was published in the October issue of the Annuals of Thoracic Surgery which is the official journal of the Society of Thoracic Surgeons. The study reported data from 36 trial centers and 83 centers that implanted patients following the April 2008 FDA approval for bridge-to-transplantation.

Key findings of the data included Kaplan-Meier survival of 89% at six months and 85% at one year for commercial patients along with declines in most adverse event categories for commercial patients versus those in the trial. These outcomes were achieved despite the fact that over 60% of the commercial patients were classified as INTERMACS profile 1 or 2 representing the most compromised of heart failure patients either in critical cardiogenic shock or in progressive decline on inotropes.

Notably catastrophic adverse events were rare with device replacement and stroke confined to just 1% and 6% of patients respectively. The authors concluded the survival rate of a large group of continuous flow LVAD patients in a real world setting has improved since the clinical trial. These data show that excellent outcomes have been maintained with dissemination of new LVAD technology from a clinical trial phase to more broad based used in the period after-market approval.

While we continue to see impressive benefits from the use of the HeartMate II among the currently indicated patient population, we are also making steady progress with our longer term strategy to broaden the universe of patients that we can serve with mechanical circulatory support by generating new data on the use of the HeartMate II and targeted underserved patient populations, and by advancing our product development pipeline.

With respect to clinical research, momentum behind our roadmap study continues to build. Three of the centers serving on the roadmap steering committee have now received the IRB approval and we expect that the first implant will occur in the very near future. As a reminder, roadmap is a post market study involving ambulatory advanced heart failure patients to meet HeartMate II’s existing FDA approved indication for destination therapy, but we are not being referred for IVAD therapy in meaningful numbers.

We anticipate that roadmap will eventually include up to 50 sites and 200 ambulatory NYHA Class IIIB and IV patients who are not dependent on continuous inotropic support, or those typically classified as INTERMACS category IV, V and VI. But we believe there remains a substantial unmet need for treatment options to improve functional status and quality of life.

Turning to our product pipeline, we were pleased to see many of you at our Technology Fair at the HFSA Meeting in September at which we featured our HeartMate II, HeartMate III, HeartMate X fully implantable, Left Ventricular Assist System, the CentriMag and the PHP.

As we indicated in our last call, we plan to provide a comprehensive update on our pipeline in early 2012. Today I’ll just provide recent regulatory updates for a couple of key programs.

With respect to our Percutaneous Heart Pump or PHP, we recently held our pre-IDE meeting with the FDA which went well and helped to find the plan for validation and verification testing of the product prior to initiating human clinical trials. As for the HeartMate III, we expect to have our second pre-IDE meeting later this quarter to discuss clinical trial strategies. For both products, we continue to target first-in-man implant by the end of 2012.

Lastly, we are pleased with the progress made to-date in integrating the Levitronix Medical franchise. We are now shipping all U.S. products through our Pleasanton facility and we have trained the global field team on both the CentriMag and PediMag platforms. The field team is responding with renewed enthusiasm for CentriMag adding 11 new accounts since the transaction closed in early August and we continue to view the acute surgical business as an important strategic element of our boarder product offering to customers.

In closing, I would like to provide some additional thoughts on our revised outlook for 2011. During the third quarter, we experienced a larger than anticipated pullback from our strong second quarter results. Based on our interactions with implant centers as well as the referral community, we see no fundamental change to our longer-term outlook for the VAD market and for the full-year we anticipate healthy underlying market growth in the upper teens on a year-over-year basis.

That said we’re not experiencing the same level of underlying growth in the second half of the year as we did in the first. As a result, our current outlook for 2011 revenues is now $418 million to $423 million, roughly 1% to 2% below our previous range. Despite this modest change though, we are raising our guidance range for earnings per share based primarily on our strong gross margin trend year-to-date.

Thank you again for joining us today and I’ll now turn the call over to Roxanne.

Roxanne Oulman

Thank you, Gary. Before reviewing our results, I want to remind you that non-GAAP net income excludes the tax effective impact of amortization of intangibles, share-based compensation expense, transaction cost and inventory fair market adjustments related to Levitronix Medical acquisition and the accounting for convertible debt instruments that may be settled in cash. You can find a reconciliation between our GAAP and non-GAAP results in our press release at thoratec.com.

Revenues for the third quarter of 2011 were $102.6 million compared to revenues of $91 million in the third quarter a year ago. For the first nine months of 2011, our revenues were $313.3 million versus $285.4 million in the same period a year ago.

Non-GAAP gross margin for the quarter was 71.6% versus 68.9% in the third quarter a year ago. Factors impacting gross margin versus the prior year include favorable foreign exchange and pump to non-pump mix.

Non-GAAP operating expenses for the quarter were $36.3 million versus $30.8 million in the third quarter a year ago. Factors impacting the increase in operating expenses year-over-year include the addition of Levitronix Medical, increased spending on product and market development initiatives and continued expansion of our research and development and field organization. Non-GAAP operating margin in the quarter was 36.2% versus 35.1% a year ago.

On a non-GAAP basis the company’s effective tax rate for the quarter was 32.9% versus 35.5% last year. The rate was impacted by a one-time favorable benefit related to California research and development credit and the favorable returned provision adjustment. In addition, the company was unable to recognize federal research and development credit in the third quarter of 2010 due to the absence of enacted legislation.

Non-GAAP earnings per diluted share in the quarter were $0.41 compared to $0.32 a year ago. Weighted average diluted shares outstanding for the quarter were 60.7 million versus 56.9 million a year ago.

With respect to the balance sheet, we ended the quarter with $232.6 million in cash and investments. This compares to $298.5 million at the end of the second quarter and $469.5 million at year-end expense in 2010.

The balance at the end of the third quarter versus the second quarter reflects the impact of the $110 million payment related to the Levitronix acquisition that occurred during the third quarter. As a reminder, our cash balance versus the end of 2010 also includes the impact of the retirement of all of our outstanding convertible debt in Q2 2011 which included a cash outlay of $164.4 million and a $50 million share repurchase in Q1, 2011. With respect to our guidance in 2011, as Gary mentioned, we now expect that revenues for the full year will be in the range of $418 million to $423 million. Our range reflects the seasonality that we experienced during the summer which was modestly heavier than expected as well as the fact that in plant activity following the summer months has not rebounded to previously anticipated levels.

Turning to non-GAAP gross margin, we have raised our outlook to approximately 70.5% compared to our previous range of 69% to 70% reflecting our strong year-to-date performance. Meanwhile, our expectation for non-GAAP operating expense growth is approximately 13% compared to 15% to 17% previously.

We expect a meaningful increase in operating expenses during the fourth quarter as we continue to invest in market development initiatives and as a development of our next generation pump platforms and our fully implantable Left Ventricular Assist System progresses into more resource intensive stages.

Turning to earnings per share, we have raised our guidance for non-GAAP EPS to a range of $1.48 to a $1.52 representing year-over-year growth of 20% to 24%. Thank you for joining us today and we will now open the call to your questions. In the interest of time, please limit your questions to one and a follow-up. Operator, we are now ready to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we will take our first question from Rick Wise with Leerink Swann.

Unidentified Analyst

Hi guys this is [Danielle] on for Rick. Just to touch on the lower guidance and market growth, can you give a little bit more color what is driving the slower second half growth industry and seasonality, but can you give us a sense is it more in DT versus VTT, it actually looks relative to our estimates international was stronger than we looked for, so. It looks like it’s mostly US focused, I mean any color you can give there would be great.

Gary Burbach

Sure, yeah a few thoughts there. You know as we mentioned the summer was a bit below expectations and then kind of the ramp post summer. We haven't seen it kind of accelerate as much as we anticipated when we established our guidance after the Q2 call and so in terms of some of the factors there, I think there was some greater seasonality than anticipated.

I think there is also an aspect of lumpiness that we've obviously seen overtime including last year. We obviously had a strong first half of the year particularly the first quarter that translated to a bit of a slower, while still growing second half of the year. Right now this year looks kind of similar to that in terms of maybe a bit of kind of digestion by the centers of the large volume of additional ongoing patients.

The growth in ongoing patients is actually substantially greater than the growth in implants. Our estimate is right now versus a year ago that the centers are managing 40% more ongoing patients. So I think there is potentially some capacity kind of incorporation and kind of need to expand capacity abilities in terms of VAD coordinators et cetera to be able to continue to move forward with more aggressive growth.

I think those are market factors and then kind of particular to Thoratec, I think as we look at now with a little more time since Q2 that Q2 we probably did have some benefit from the data that HeartWare presented at the ISHLT meeting. And some of the pick up that we saw in Q2 may have been related to that and then in Q3, we saw I think a more rapid kind of reacceleration by some of the centers in the clinical trail where you know maybe they decided to implant patients a bit more aggressively and kind of continued to drive more aggressively towards completion of that trial activity.

So I think that combination are kind of the key factors that we see.

Unidentified Analyst

Okay, great. And then just a follow up really quickly on the log jams you were talking about at the centers, what are the logistics that you guys need to work through with the centers to sort of get through those obstacles and how quickly can you do so I mean is this a year-long thing or?

Gary Burbach

Well, last year it was you know kind of the second half we saw, that kind of a process. I don’t think we see something fundamentally different. You know we see similar enthusiasm towards the therapy and desire by centers to continue to build their programs. So I don’t think there is a kind of a bigger time horizon required to kind of continue to build programs. Some of it are things that centers have to do on their own.

You know kind of continue to build administrative support for continued investment. You know, kind of others are things that we are trying to support, things like we’ve talked about the Shared Care program, that takes some of the resource load off of the centers. We’re continuing to proliferate that program in to the implanting centers and their referring centers. So, those are the kinds of things that we’re trying to do to facilitate it as well.

Operator

We will take our next question from Larry Biegelsen with Wells Fargo.

Larry Biegelsen - Wells Fargo

So HeartMate II unit growth year-over-year and sequentially in the US and [OUS], Gary, year-over-year was it about 10% in the US in line with your US pump growth and about 5% OUS, is that correct on a year-over-year basis?

Gary Burbach

Yeah, that’s about right.

Larry Biegelsen - Wells Fargo

And so, outside of the US, it looks like you did lose a little bit of share. Any comment on that?

Gary Burbach

I think, kind of from our view of the market, it looks to be pretty consistent. So, you know, from kind of our analysis of it, it doesn’t look like there is really any significant change.

Larry Biegelsen - Wells Fargo

And then, you know, why did you still believe that 10,000 pumps worldwide by 2015 is realistic? I mean you just touched upon the capacity constraint. We are hearing a little bit of chatter on reimbursement issue for Destination Therapy, just not robust enough, and lastly, when would you consider increasing your spending to drive faster growth?

Gary Burbach

Sure. Also, relative to the first question, you know that expectation we’ve said some time ago, and we are going to re-affirm it at the beginning of this year when we set our guidance for the year. Expectations for our market growth and in the guidance that we are providing right now is actually consistent kind of a market employee tech basis to the guidance that we provided at the beginning of the year. So, from a kind of a broader time horizon looking at the full year, you know, I think it’s consistent with the expectations we had at that point.

In terms of definition therapy reimbursement I think that’s truly that we do hear some centers, you know some concerns around the DT reimbursement, they don’t give the second DRG. Obviously which they do with bridge to transplant when the patient then gets a heart, and so I think that may create some instances where for less capitations that are seen thicker and they are potentially going to have a longer course of therapy to be more expensive that there is prospects sometimes from administration, and you know they are less likely to do those.

So I think it redoubles the importance of the efforts like roadmaps to enable the centers to really access the patients that are already indicated for the device where there is going to be a shorter length of stay, you know, a better course of therapy both clinically as well as economically.

And then lastly in terms of increasing our investments you know we are doing that currently. The guidance that we provided indicate the pretty significant step-up in spending in Q4 and that’s really focused on two areas continuing to expand our investment in our key product development programs like HeartMate III, the fully implantable system PHP and then secondly continuing to expand our investments in those market development initiatives including the world maps study as well as the variety of other vehicles.

Operator

And we’ll go next to Jason Mills with Canaccord.

Jason Mills - Canaccord

Hi guys. Thanks for taking the question and first off congrats on the Cardinals. So I am just sticking here in the US just while you haven’t given any guidance here for 2012, you sort of bracket it by giving some more near-term guidance and then to Larry’s question talking about seeing consistent trends towards your long-term assumptions, how should we think about the market growth here in the US in 2012, at least from a preliminary standpoint? Should we, do you think it’s going to high teens range?

Gary Burbach

Yeah, we’re not ready to give specific guidance for 2012 yet, Jason, but certainly we expect to see continued solid market growth in the United States, and the key catalyst of that being continuing to drive the destination therapy indication. As we mentioned before, we are optimistic that as hardware receives an approval but that will be catalyst for continued growth and expansion of the market in the US similar to what we saw in Europe.

Jason Mills - Canaccord

Okay. And then back to your commentary around what centers are dealing with here in the US? In prior quarters, I believe, the question has been asked sort of in a couple of different ways, and the commentary back was at least to way we’ve heard it is just not seen much in a way of constraints. I am wondering what specifically in your mind during your research has changed there, and again just asking the question again, what sort of timeframe within which do you expect there to be sort of less pressure on the hospitals and the ability perhaps to take on more patients?

Gary Burbach

So we did talk about kind of similar topic back late last year when we saw kind of a similar dynamic and so it’s not kind of unprecedented or new really, and in terms of the centers, kind of, being able to work through its obviously we are going to vary center to center. But, generally as was mentioned earlier kind of a six-month kind of timeframe, I think is kind of what we saw last year based on what we know at this point. You know I don't think its unreasonable to expect a similar kind of progression as they go through the process currently and it’s not, again it’s not consisting other centers that are still driving forward aggressively. There are others there that are kind of moderating a bit more. So it’s again very much a center-to-center situation.

Jason Mills - Canaccord

Just a quick follow-up to that, what we are hearing is a increase in referrals pretty consistently strong and then dedication of additional resources at existing centers seem to be strong as well. So, I guess the bottom line question is where are these patients sort of going. There seems to be more and more patients in limbo as we've got capacity constraints within the system which is somewhat of a positive, if that's true, in terms of longer term growth, but I am just wondering where these patients are going?

Gary Burbach

Well, you have to remember if you look at the year we are even though the forecast is down slightly, we are still projecting growth in the second half of the year, and for the year overall we are projecting market growth in the upper teens. So there are significant numbers of additional patients that are being treated currently. There maybe a small portion of them kind of particularly sick problematic patients, you know patients that kind of centers or particularly concerned around the economics that are being turned away would be the only other population that I could point to outside of the growth that we are seeing.

Operator

We’ll go next to Bob Hopkins with Bank of America.

Bob Hopkins - Bank of America

Great. So just the first question on the revenue guidance, you are lowering it by mid point to mid point you know little over so in the $5 million to $6 million range. And I was wondering if you could talk a little bit more about is that for you to transplant Destination Therapy U.S., OUS just give us a little more color on the specifics of which geographies and which pumps you are lowering your estimates for?

Gary Burbach

Okay. Its predominately U.S. based that’s kind of where the largest portion of the growth is coming and you know the Q2 ramp-up that we saw that caused us to increase our guidance was really it’s going to be U.S. centric phenomena and then kind of moderation that we have seen through the summer and kind of into the beginning of the fall is against that same backdrop.

So it’s predominately U.S., predominately HeartMate II the PVAD as we mentioned did quite well in Q3. We don’t expect that to be an ongoing trend, but that’s not a kind of particular change as it effect on our guidance. And then relative to DT and bridge, predominately DT, as you know, the kind of the vast majority of the growth, that we’re projecting now and into the future is DT-based.

That said, in Q3, all the growth came from DT. Bridge was flat though versus you know we generally have expected kind of mid-single digit percentage kind of growth rates in bridge. So we did see a little bit of a downturn in bridge. That did affect the numbers a bit, particularly during the summer.

Bob Hopkins - Bank of America

Thank you. You mentioned U.S. centric, but I believe in the last call, you said that HeartMate II units were up, I think roughly 20% OUS and this quarter they were only up 5% according to what you suggested earlier. So do I have my numbers wrong or you know, it feels that there was also a pretty decent slowdown OUS in your HeartMate II units year-over-year?

Gary Burbach

Yeah, relative to kind of our, the question again was wrong kind of a guidance explanations. I wouldn’t say that kind of the change in HeartMate II from Q2 to Q3 really was different than what we would have anticipated.

Bob Hopkins - Bank of America

Okay. That’s helpful and then on global market growth, you are saying, I think when you are rephrasing the high-teens number, is that a global LVAD unit growth or is that revenue growth or just specifically what you’re referring to there?

Gary Burbach

Yeah, that is units Bob, and it is also – you’ll recall, we pretty consistently talked about the bolus of activity that we had back in Q1 of last year. So it is net of that roughly $7 million that we’ve used to come up with that number. If you don’t use that, then I think it comes down maybe a couple of percentage points.

Bob Hopkins - Bank of America

So what does that imply about back half’s market growth?

Gary Burbach

Back half market growth in the low-teens

Bob Hopkins - Bank of America

Okay. And lastly from me, on the capacity issue given what you are seeing out in the field in terms of the need for more basically infrastructure development I guess for lack of a better term, do you think the market can grow greater than this high teens level that you are projecting for this year? What is the ability of the market to grow relative to the capacity constraint that you seeing when you look out you know again for the rest of this year and into next year; is there a cap we should be thinking about in your minds?

Gary Burbach

If you look at the multi-year projection that we provided that was a kind of high-teens multi year kind of number. So that’s kind of the number that we have put out there for a multi-year kind of horizon, I think that’s still kind of a reasonable number at this point. And if we look backwards, the past few years, obviously the market has actually exceeded in the U.S. that kind of a growth rate.

So I don’t think that’s unreasonable growth rate in terms of the ability to realize that; that’s not going to be the case every year. We have talked about that there is probably going to be some ups and downs and particularly as we have new products kind of have entries those are the things that capitalize the markets. But in terms of kind of capacity expansion, I think that’s a reasonable number.

Operator

And we’ll go next to Chris Pasquale with JPMorgan

Chris Pasquale - JPMorgan

Gary, your comments suggest that you saw really a big jump in PVAD, IVAD sales OUS compared to the first half of the year. It that right and can you add any color on how the international growth broke down and why you think that might have been?

Gary Burbach

The PVAD, the large PVAD growth was a Q3 year-over-year number that I was referring to. So that’s Q3 of this year versus Q3 of last year. And in terms of why, PVAD is very much bridge-to-transplant predominantly by that which are kind of the sickest patients and obviously in relatively small numbers so that tends to be particularly lumpy. So I don’t think there’s any kind of particular trend there that you should be kind of trying to extrapolate on, I think it’s just in the kind of give and take of that business in the way it goes.

Chris Pasquale - JPMorgan

Okay. And then on the DT reimbursement issue that you brought up, do you think that DT implants are profitable for centers today given the longer patient follow-up and management post implant and the lack of that second payment for a transplant at the end of therapy?

Gary Burbach

I think for most centers based on our analysis, the answer is yes. The key is to managing that effectively and being profitability or one-patient selection as I mentioned earlier not implanting patient that are INTERMACS 1 and going to be in the hospital for months and months and cost a tremendous amount of money it’s kind of definitely the most significant factor and then two having some reasonable mix in terms of payer mix, so some reasonable portion of private pay tends to be an important aspect of that as well.

Chris Pasquale - JPMorgan

Okay. And then just one last one if I can, gross margin continues to really outperform expectations. On previous calls you had talked about some of that strength in the first half of the year being unsustainable, but we saw it again this quarter. So as we look into 2012, what's the kind of adjusted baseline number we should be thinking about for you guys?

Roxanne Oulman

Chris this is Roxanne. From a 2012 perspective, I think it’s too early to project what we think gross margin will be and provide any guidance. As you alluded to, we've shared previously during the first half of the year that we've experienced favorable absorption variances as a result of inventory build that we had in Q1 for sealed grafts and then we've seen some favorable fluctuations in our inventory reserves and customer mix. So once again, I think it’s too early to project what we think will happen in 2012.

Operator

And we’ll take our next question from Tom Gunderson with Piper Jaffray.

Thomas Gunderson - Piper Jaffray

I know we've got this capacity issue that we want to talk about, but I’ll take the other side of it and see what we can talk about market development. Can you Gary give us a little bit more color on the referral, the reaction from the audience in Orlando and if you are going to be establishing 15 to 20 more centers next year, I think the capacity starts to dwindle and we will start talking about the referral network again. I want to get ahead of that. What's the timing? How many of these were new guys, how many of them are doing a little referral. How many of them, give us a sense of the audience out there and what you expect from that meeting.

Gary Burbach

Yeah, that meeting is really targeted at clinicians that have had an initial introduction, a significant portion of them will have had at least an initial referral to an implanting center and so it’s really looking to get them the next step down in the pathway and become a repeat refer and advocate within their practices since the vast majority of these cardiologists are within multi-physician practices and really start to move them towards being a champion of the therapy.

And so you know the strategy is, it takes multiple interactions and exposures to the therapy to move these physicians through kind of the phases of adoption from awareness to champion and this is kind of right in the middle of that process. This was substantially larger.

This is I think the fourth one of these events that we’ve done now. We started the first one early last year. Initially the first one is about 40 clinicians, this one was a 140. By expanding the scope, we’re able to really bring kind of phenomenal faculty to bear in terms of kind of a really world class set of luminary cardiologists and surgeons.

There are ongoing current patients that are an active part of the program. And the reception is very, very positive. We’ve heard already kind of post meeting certain physicians that are kind of you know changing their view towards the therapy, kind of an increased focus towards you know referring patients that they weren’t really seriously considering previously. So our expectation next year is definitely to continue to expand the investment in this kind of program.

Thomas Gunderson - Piper Jaffray

And then just a related quick question, on your market development specialist I think you said you had 40 last quarter and you are hoping to have 50 by the end of the year, is that still on target?

Gary Burbach

Yeah, I think the numbers were slightly lower than that and I don’t have them right in front of me here, but I think we had 30 or so and we’re looking to expand towards 40 and we’re on track for that expectation.

Operator

We will go next to Rajeev Jashnani with UBS.

Rajeev Jashnani - UBS

I guess, to build on the capacity question, it sort of implies that there are patients who are being rationed, that aren’t being implanted, that would be suitable for LVAD treatment and is that really what you are seeing out there and think that’s a major impediment to our part of the impediment to growth at this point?

Gary Burbach

Yeah, it’s important to put it in the context, right? We lowered our guidance by 1% to 2%. You know, so, it’s not a dramatic change in numbers that we’re talking about. Here we’re talking about a relatively small number of patients and so, are there patients that are not receiving care that should, absolutely. I mean that’s kind of the fundamental premise of our growth expectation in the near term and the long term.

Most of those patients continue to be constrained, back in the referring physician community and in terms of patients that are you know kind of giving the centers and not being implanted. I think the bulk of that, you know, currently is still in the form of being more selective around patients that may have more kind of difficult economic outcomes you know in terms of kind of who might they not implant and then two, a less aggressive posture in terms of time spent out in the community driving the referral process being out there trying to cultivate their referral channel.

Rajeev Jashnani - UBS

And maybe following up on Europe market growth, 2010 market growth was extremely robust this year, it’s robust, but not quite as good and I am just, perhaps you could add some perspective there in terms of how you see that market unfolding going forward given, I guess an implant per capita that’s still much lower than what we see here in the US?

Gary Burbach

Were you asking about Europe specifically? So our expectation actually within the guidance that we provided is you know Europe that we would see you have on a year-over-year basis, very little growth in terms of the market, year-over-year Q4 to Q4 because last year Q4 you may recall was a huge quarter, where the market just grew spectacularly, a significant amount of that growth was in what I will describe is kind of more peripheral markets that are generally served by distributors and our expectation is not to see that kind of activity this year in those markets and some of that’s because of the macroeconomic factors that are going on in various parts of Europe, countries like Italy where we see activity down because of some of those concerns.

Rajeev Jashnani - UBS

And I appreciate that, but may be those are some interesting points you raised. Perhaps you could expand on that and talk, perhaps not getting into guidance, but talk a little bit about those trends as we’re getting into 2012 in which you might expect to see there into those peripheral markets?

Gary Burbach

Yeah, over the longer term, certainly, we expect to see continued significant growth opportunity internationally not just in Europe but also Asia-Pacific. Next year, we expect to launch in Japan in the second half of the year. Relative to Europe, I think in terms of the core countries, the expectation would be to see kind of solid continued growth, relative to some of those countries where you got some of the more significant macroeconomic questions on the table. I don’t think we can answer that until those things hopefully sort themselves out here in the near term.

Operator

And we’ll take our next question from Matt Taylor with Barclays Capital.

Matt Taylor - Barclays Capital

First question I want to ask was your profitability has been good and improving and wanted to ask you really what the source of that is and also, if you had seen any changes on pricing sequentially or year-over-year in US or Europe?

Gary Burbach

Sure, so in terms of pricing, ASPs have actually been quite stable. So not kind of significant changes on that front. In terms of profitability, we’ve seen nice improvement in our gross margins and that as a number of sources including scale, kind of in terms of enduring sources, scale is certainly a positive, the Levitronix acquisition and the gross margins associated with that are positive. We have as we have talked about a little bit earlier, the one-time benefits, some inventory build up that happened at the beginning of the year where we had some positive manufacturing variances as well.

Matt Taylor - Barclays Capital

And then follow-up question, there's been quite a bit of focus on the capacity issue on the call and I guess I am trying to sort of reconcile what you are saying about second half capacity and demand with your talk about next year being still high teens, I mean are you seeing capacity issues now, do you expect them to be resolved by next year or do you think it’s going to be less of an issue next year or what's the difference between the two periods there?

Gary Burbach

Yeah, so one I want to clarify I wasn’t providing specific growth guidance for next year. So I was talking about kind of multi-year projection has that kind of growth, but if not, I did not indicate next year specifically. We are not prepared to provide a specific number for next year.

I did say that I believe that kind of solid market growth is a reasonable expectation for next year and if you look at this year, we had high teen growth. We felt like we had some similar capacity challenges in the latter part of next year that you know kind were digested and worked through additional resources and investments put in place. So we don't feel like from what we see right now, the cycle looks substantially different from what we saw a year ago.

Matt Taylor - Barclays Capital

So you see it as more of a lumpiness than a fee change there?

Gary Burbach

Yes, that's exactly right.

Operator

And we’ll take our next question from Jayson Bedford with Raymond James.

Jayson Bedford - Raymond James

Just a couple of quick easier -- you mentioned the larger than expected pull back in reference to the guidance here, and just to be clear you are not suggesting that there was any excess inventor built up in 2Q, it’s more demand related, is that fair?

Gary Burbach

That’s absolutely correct.

Jayson Bedford - Raymond James

Okay. And then just in terms of the trends in referral you kind of touched on it, but and then I realized this is probably a better question for the implanting centers, but from your standpoint, are your customers getting better referrals meaning candidates that are better suited for VAD. I know earlier in the year you talked about a large percentage of your referrals that were not really suited for VAD?

Gary Burbach

Right, I think slightly better, you know, that’s relatively slow process, and I think that because you’ve got a mix physicians that are becoming repeat refers, that are becoming better and kind of giving feedback and they are kind of zeroing in on the bulls eye. But then you also through our market development efforts, you know, you have a large population of new referrals that are kind of early in that process I mean in the first or second patients that really haven’t come up the learning curve. Though, it’s a pretty slow process of that becoming your kind of substantially better?

Jayson Bedford - Raymond James

Okay. And since no ones have asked about Levitronix you had some nice growth in the US there, you mentioned that I think 11 new accounts, how many do you have in total? And I am guessing you saw better volumes, you know in just the new accounts?

Gary Burbach

So roughly a 117 in the United States accounts with the CentriMag system and definitely we saw about 15% growth on a year-over-year basis. And the bulk of that was from kind of same-store sales, increased activity versus the new centers.

Operator

And we will go next to Bruce Nudell with Credit Suisse.

Bruce Nudell - Credit Suisse

Thanks so much for taking my questions. Gary, the Ex-U.S. markets are a little impenetrable because of other players that we don’t -- that may not publicly report, and so we are sort of guessing that year to about 50% unit share, you know, HeartWare is 35 to 40 and others 10 to 15. Is that about right?

Gary Burbach

I think the other is slightly lower than that. You know, I think that we try put the other somewhere a little bit below 10%.

Bruce Nudell - Credit Suisse

Okay, that’s great. You know better than us certainly. And just thinking about it from a strategic investment point of view for people looking at Thoratec, I mean, you know, our view is this market has inevitability to enter -- it’s the only therapy where there is no alternative. The question is how should investors think about that, kind of, awkward period when HeartWare gets in to the U.S. market and just has to take a chunk of share and U.S. market is probably twice the size of the Ex-U.S. market. What would you have investors think about?

Gary Burbach

You know, I think, certainly there is a couple of aspect to that. One, they are only entering the market for Bridge-to-Transplant and the Destination Therapy market is the growth side of the market, you know, really for the future, and we believe it will be a number of years after they receive bridge approvals for you know they are likely to receive destination therapy approval.

So we do feel like there is a significant and growing portion of the market that we have a secure position in and that with that entry we do expect that to be a catalyst for growth, and so as we -- if we look out at what happened in Europe you know our hardware had a very successful ramp-up over the course of almost three years now, and during that same time period we have had a very solid period of growth across every one of those years. So I think it’s clearly a market that’s still early enough – has enough growth potential that kind of success of a new entrant doesn’t have to be to the detriment of the existing market leader.

Bruce Nudell - Credit Suisse

And my follow-up question is on you know the pair mix in DT versus BTT, and clearly the commercial payers across all med tech pay 1.5 to 2 times Medicare the question is going to be where do you see the ultimate DT pair mix, and also is there something you can do on the Medicare side where you know may be split LVAD from that overall DRG so that it gets a better accounts for the costs incurred by these Medicare insured DT type patients?

Gary Burbach

Right. Well certainly, you know, I don’t have a specific number in terms of kind of how that mix is likely to play out long term, but certainly the expectations would be that the majority of the patients – substantial majority of the patients would be Medicare patients, and you know I think the second part of your question is the most important aspect and we do think there’s a good opportunity there to increase the reimbursement for Destination Therapy by splitting it apart from transplant the two or lump together.

We’ve actually initiated that dialog with CMS. Their process obviously doesn’t happen overnight, but that’s something that we initiated here a few months ago with them and we’ll bring the data to the table and if that were to occur that would actually provide a pretty nice bump to destination therapy reimbursement.

Bruce Nudell - Credit Suisse

Just where do you think the cost basis for a hospital for a Medicare-type DT patient?

Gary Burbach

Well, that varies a lot, but you know the current reimbursement is on average about $190,000, and from what we see the majority of the hospitals are able to make a profit at that reimbursement level, and as I mentioned earlier the big, big determinant is what kind of patient are you implanting, are you doing an INTERMACS 3 or 4 or 5 versus what you’re doing a INTERMACS 1 or 2 and those huge differences in cost, length of stay, for those different patient types.

Operator

And we’ll take our question from Suraj Kalia with Rodman & Renshaw.

Suraj Kalia - Rodman & Renshaw

Hi guys. Gary, I just want to go back in terms of understanding the core issues here. If I look at hardware numbers for Q2 and Q3, correct me if I am wrong, I believe the implant, they sold like 74 units in Q2 and I believe it was 91 in Q3, so -- and that’s a delta of about let’s say a little less than 20 units and I have just done some rough very rough math on HeartMate II units in the US, I am getting somewhere close to 40 to 50 units sequential decline, am I too far off on the math and I am not asking for specifics, but am I too far on the math and just trying to correlate it to your capacity issues that you are talking about?

Gary Burbach

Yeah, certainly the decline in the HeartMate II units was greater than the increased heartwares on their trial and we obviously expected that there would be a sequential decline as I mentioned that decline was a bit greater than we anticipated, and that was the combination I think of the ramp up that they did see in their trial during the quarter.

We weren't expecting them to have as much of a ramp up as they had during the quarter that seasonally a down quarter, but then there's clearly also a more significantly that kind of lumpiness that we've seen in the past and we believe that similar dynamic is at play here.

Suraj Kalia - Rodman & Renshaw

And just to understand the seasonality a part better, Gary I mean, all US you guys seem to have held up pretty well at least based on the numbers. When you look at the market shares that we just talked about that also jives with a numbers that you all have put in the press release, what I am trying to understand Gary, is if you look at Destination Therapy reimbursement, I mean, that roadmap has existed for some time now. So the reason hospitals are preferring the BTT, we also understand because of heart transplant codes later on addition of that. We get all that, but that’s nothing change there and I am just trying to understand what was the key seasonality in the U.S. or really trying to understand this capacity issue a little better, because when I tie this element in terms of reimbursement being what it has been for so long and that is one point.

The second thing is if you look at the EACTS presentation of HeartMate, one of the physicians mentioned, hey BTT is slowing down and DT is where the action is; can you help us reconcile the two vis-à-vis reimbursement, vis-à-vis capacity when we take into account HeartMate II in the U.S.? Thanks.

Gary Burbach

Okay. You covered a lot of ground there, I am not sure – maybe you can kind of pinpoint kind of your core question there within what the kind of situation that you just described for us?

Suraj Kalia - Rodman & Renshaw

Sure, Gary for example, much latter in the presentation, if I remember correctly one of the comments was BTT transplants are becoming longer DT is where the action is; so that’s one thing. On the other hand, we are hearing DT reimbursement is an issue, capacity constrains are an issue, but nothing there has changed really from what I see in the field. But HeartMate II units were down, I am just trying to help to reconcile the two between what people are saying versus the actual numbers on DT for HeartMate II?

Gary Burbach

So they are down sequentially which we anticipated. They are up on a year-over-year basis, so its important not to just get hung up I think on the kind of sequential comparison, but also to look at year-over-year where you know we saw about 10% growth on a year-over-year basis and that was completely driven by Designation Therapy. We saw about 30% growth in Designation Therapy on a year-over-year basis, no growth from a Bridge-to-Transplant perspective. So I think that’s consistent with some of the comments that you just made.

So it’s really just a matter of magnitude. And you know, as I mentioned in Q2, you know, we obviously saw a very big pickup in the United States. That wasn’t the case in Europe. So the dynamics in Europe are more muted than what we’ve seen in the United States and the fact is as I mentioned, the kind of what we’ve seen kind of from the progression as we ended Q2, to where we sit today are I believe a combination of a little more seasonality, little bit of lumpiness associated with that big spike that we had in Q2.

And then thirdly, you know, the HeartWare trial activity and what was probably a depressed Q2 for them, given the data that was presented at the ISHLT meeting which I think, kind of you know, helped us and increased our Q2 but that disappeared in Q3 as they regain traction in their trial.

Operator

We’ll take our next question from Duane Nash with Wedbush Securities.

Duane Nash - Wedbush Securities

Can you give a breakdown of HeartMate II versus PVAD, IVAD revenues internationally?

Gary Burbach

Yeah, we haven’t provided those specific numbers, Duane.

Duane Nash - Wedbush Securities

So I can tell you, my math suggest you have roughly 120 internationally, while being active at 139 centers which is a little less than one implant per center. On the other hand, it appears that HeartWare had roughly 142 at 70 centers suggesting two implants per center. Any comments on why these centers may be behaving so differently and what you might do to get deeper penetration?

Gary Burbach

Yeah, one to tell you directionally, your number for HeartMate II is too low and secondly in terms of the difference in implants per center you know there is a different profile to the base in that and there is still more concentrate, they obviously started very logically at the largest centers. You know number of those centers utilize the HVAD as a BiVAD which increases your implants not only per center, but per patient. And we have disseminated the technology over a broader base of hospitals and as you do that you get into more and more centers that are doing a much smaller volume of patients per year.

Operator

And we’ll take our next question from Chris Sassouni with Eagle Asset Management.

Chris Sassouni - Eagle Asset Management

Kind of watching the smart market unfold for as long as I have, I guess I am trying to figure out what’s really going on in the ground floor with this market. Nothing has changed in terms of the incidents and probably so congestive heart failure nothing has changed in terms of the entry of new therapies to address this problem. And so, well I have heard anecdotally directly from some VAD coordinators and some doctors about the notion that they were going to run up again some capacity constrains, because of the resources that needed to be deployed.

I first want to understand whether you are sensing any waning of enthusiasm for LVAD’s, I mean the surgeons have really been working hard to increase awareness and you’ve been trying to drive referrals from the cardiologist up to the surgeons. It sounds like there is a steady flow coming now.

But is there – between what’s going in the hospitals just them being under duress, not exactly know what Medicare cuts are coming down the pike. Do you get the sense that either surgeons or the hospitals themselves right now are pulling back a little bit on the amount of effort that they’re willing to deploy for LVAD?

Gary Burbach

Right, thanks Chris. In general, I would say no. In general, I would say the enthusiasm level for the therapy remains high and the commitment to the therapy remains high. I would say there are certain centers where they’ve had more challenges with their economic outcomes where administration may be in kind of a bit of a, hey let’s slow down and kind of assess where we’re at here, figure out how we kind of improve our economic picture.

So there is kind of a more of an exception basis, some of those kinds of situations, but that’s certainly not the rule. And even in those situations, there is a commitment from the clinicians to work through that and obviously it takes a little bit of time for them to do that, but they continue to stay committed to the therapy and kind of get back on a growth trajectory with their programs.

Chris Sassouni - Eagle Asset Management

Okay. So may be let’s divide it up; let’s divide the market up into those centers that you would consider the most experienced and having the highest volume and I consider that kind of the core group of hospitals. How many of those hospitals would you say are in the U.S. that are doing at least a couple a month?

Gary Burbach

So how many hospital in U.S. are doing at least a couple a month?

Chris Sassouni - Eagle Asset Management

At least a couple a month if not more, let’s say that I think the highest that I had heard from last year was a bit over a 100. So let's slice it and dice it, what I am trying to get at is, is anything changing at the big core centers that the ones, the Columbia Presbyterian of the world or some of the other centers, Louisville and other places.

Compared to those and what this is what I am trying to get at, are the centers that have relatively few that are DT certified have built a program that are doing relatively few LVAD, but still require the commitment of resources, are they saying, we’ll do a couple, but we’re not going to do that many, we’re certainly not going to do at the level that we see at larger centers?

You understand my question, there is a very big difference between an established center saying, let's move forward, let's continue to build this program versus a center that's sort of trying it out, got DT certified, but isn't willing to necessarily make the commitment to take it to the next level to say, yes, we have the resources to do two or three a week?

Gary Burbach

Right. Yeah for the first group, the larger centers, the substantial majority of those centers continue to be in a committed growth mode. For the latter group, there is a real mix Chris, some of those centers, they want to build overtime a larger scale program. There is also a fair number of them that really view this will be a kind of more modest undertaking and they are not looking to kind of grow to be a 30-40 implant kind of a center. So with that population of centers, which is generally kind of probably 50 centers or so, that we brought on more recently that kind of fall into that tier 3 category that we have described where you’ve got that really mix of, some that want to grow over time, but it’s a slower process.

Chris Sassouni - Eagle Asset Management

Okay. And my last question is where we are at now because it has a direct impact on the profitability of patient in the hospital, one is that the patients selection, but once we get past the patient selection, where do you think we are at in general in terms of standardizing protocols in terms of infection control and in terms of standardizing antithrombotic regimens and so forth. Where is all that because that’s going to have a direct impact on device infection and then device exchange?

Gary Burbach

There is a still fair amount of opportunity there to continue to standardize, disseminate best practices. So I guess I’d look at that as the glass half full in terms of continuing to make progress against you know where people have economic challenges or clinical challenges for that matter. You know I think the majority of the time that tends to be a case either as you mentioned of patient selection or not having best practices in terms of infection management et cetera.

And we actually have this year, our clinical team around the world did see customer specific initiatives to help them tackle bleeding or infection or you know kind of a length of stay, a specific clinical and potentially economic issue where you know we believe they have significant room for improvement where they may have average length of stay of 30 days versus best practice that demonstrated at more like two weeks.

So that’s a significant area of investment that we have ongoing.

Operator

And that concludes our question-and-answer session. I would like to turn the conference back to our speakers for any closing remarks.

Gary Burbach

Okay. Well, that’s everything for us. We appreciate your time and attention and we look forward to keeping you updated in the future. Thanks.

Operator

Thank you everyone. That does include today’s conference. We thank you for your participation

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